The crackdown on AIF abuse comes with some collateral damage

Banks refuse to answer VC, PE's calls
Banks refuse to answer VC, PE's calls


  • An RBI notification meant to curtail ‘evergreening’ of loans unintentionally leads to banks denying legitimate capital claims to VCs and PEs

Mumbai: India's top banks including State Bank of India, HDFC Bank and Axis Bank have walked back on capital commitments made to private equity and venture capital funds to avoid falling foul of a recent central bank circular on alternative investment funds (AIFs), three people familiar with the matter said. The development has rattled around 100 funds, the people said, putting a question mark over AIFs operating in a range of sectors including startup funding and buyout finance.

In December, the Reserve Bank of India (RBI) asked banks and non-bank lenders to sell investments in AIFs linked to their debtor companies. PE and VC funds raise significant amounts from domestic banks through AIFs, which they invest in companies across sectors. Once a fund manager finalizes an investment, a capital call is made - a request to draw down the promised money.

In a recent case, SBI declined a capital call from the sovereign-backed National Investment and Infrastructure Fund (NIIF), two of the three people cited above said on condition of anonymity. The bank has also declined capital calls from its own funds, a third person said, referring to several funds owned by India's largest bank by assets. SBI, NIIF, HDFC Bank and Axis Bank did not respond to requests for comment.

Banks, which are limited partners (LPs) or investors in these funds, have referred to the RBI circular and invoked “force majeure" or “An Act of God" to decline the promised capital, the people added.

According to the people cited above, the regulators identified four NBFCs close to AIFs which were suspected to be helping in evergreening loans. The RBI circular pointed to situations where lenders were investing in their own captive AIFs which had links to their own bad debt. In January, Sebi identified 30,000 crore worth of investments related to such evergreening of loans.

“However, the uncertain language of the RBI circular has prompted banks to deny capital calls across the industry, even to legitimate AIFs," said the second person cited above, an investor whose fund was impacted.

According to industry estimates, Indian banks have invested around 12,000 crore in Indian PE/VC funds over the last 20-25 years.

“The RBI guidelines have caused some stress on Indian AIFs, given that banks have started to reconsider deployment in funds which have common portfolios and this, in turn, has resulted in the funds having to delay committed rounds. It is imperative that the guidelines issued be revised to provide a breather for the regulated entities which would help getting life back to normal for the funds," said Ritesh Kumar, partner at consulting firm BDO.

The circular penalizes banks for making investments into AIFs even when they are legitimate or genuine investments, Kumar added.

“What this instruction also ignores is the essential fact that no one LP is in a position to decide or control the management of the AIF and that the fund managers (along with an investment committee, in some cases) take the investment decisions. The instruction appears to disregard the independence of the investment manager and presumes a malafide intent by default," Kumar said.

The Indian Venture and Alternate Capital Association (IVCA) has been lobbying the banking and markets regulators to relax the new rule.

“The changes by RBI to place greater restrictions Banks and NBFCs (REs or regulated entities) investing in funds and their portfolio companies has disrupted the capital call process for various AIFs in India," Siddarth Pai, an executive council member of IVCA said. The RBI circular does not differentiate between debt and equity, and makes broadbased, Pai said.

“Several managers with REs (regulated entities) as investors have put their capital calls on hold as their fund documents require all Investors to fund capital calls at the same time. In other cases, banks have shared legal opinions stating their inability to fund capital calls due to the RBI circular on the same," Pai added. Regulated entities refer to banks, non-bank lenders and other entities under the regulator's authority.

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